OCTOBER/NOVEMBER 2013 SA MINES & ENERGY JOURNAL
37
BUSINESS
Thin edge of
the wedge
Changes to rules around thin capitalisation and
exploration deductions mean companies have to
dramatically increase the equity they contribute to new
Australian investment projects. Michael Churchill and
Kalem Sammut discuss.
Major changes affecting foreign
investment in Australia and
the future of mining investment
were largely overlooked in the
Federal Budget earlier this year as
the public focused on the size of
the government deficit.
Reduced allowances for mining
exploration deductions announced
in the 2013/14 Budget have forced
mining companies to be more
focused on correctly allocating
value amongst production
and exploration assets.
The removal of Capital Gains Tax
exemptions for foreign investors
means more attention must be
given to acquisition valuations
to achieve a fair value for the
assets considering the cash
required to pay tax liabilities.
Previously, mining companies
that acquired exploration assets
-- including mining rights and
information -- could claim an
immediate tax deduction. This
concession has been amended
and exploration assets must
now be written off over 15
years or the life of the mine
(depending which is shorter).
This change is in effect now.
This means a company takeover
resulting in a $100 million tax value
allocated to exploration tenements
and information would previously
have made an immediate tax
saving of $30 million. Under the
new laws, this $30 million benefit
would be spread over a maximum
15-year period, with a present value
closer to $10 million (assuming
a discount rate of 8 percent).
Deal metrics are instantly less
attractive to acquiring companies
and lower prices may end up
being paid in acquisitions. It is
important for miners to consider
the potential deductions they are
eligible for under the new laws,
as they are estimated to cost the
mining industry $1.1 billion over
the next four financial years.
To date, the majority of miners
use historical cost as the value of
their rights and information. This
method is neither accurate nor
ideal and is potentially exposing
the company to unnecessary
stamp duty under the landholder
regime -- triggering tax liabilities
under the Taxable Australian
Real Property (TARP) regime
and exposing the company to
an unnecessarily excessive tax
liability under the new mining
rights and information regime.
It is important that mining
investors accurately allocate
value between exploration and
production assets in order to
minimise their tax liability.
Foreign investors who dispose
of mining entities where the value
of non-TARP assets exceeds 50
percent of total assets are exempt
from paying Capital Gains Tax.
Previously, mining information was
classified as a non-TARP asset,
increasing the ratio of non-TARP
to TARP. This is especially relevant
for early stage miners who hold
high levels of information and
lack income producing assets.
Mining information and goodwill
must now be valued and included
together with the mining rights.
For early stage miners, this
effectively lumps all assets into
the TARP 'bucket' and gives rise
to a tax liability upon disposal.
Also, under the stamp duty
regime, mining information is still
classified as a non-land asset.
Therefore, correctly valuing mining
information is still important if
miners wish to minimise their
potential tax payment. Ignoring
this valuation issue can lead to an
excessive stamp duty tax liability.
In addition, from 1 July 2016, a
10 percent non-final withholding
tax will apply to the disposal of
all TARP assets by any foreign
investor. The purchaser is obliged
to withhold and remit to the
Australian Taxation Office 10
percent of the total purchase price.
Foreign investors should place
their valuation method in the
spotlight to ensure acquisition
bids are competitive without the
new tax requirement harming
future operations or creating
excessive liquidity constraints.
Together, these changes will
cost foreign investors $219
million over the next four financial
years. Foreign investment could
suffer as more cash generated by
asset sales finds its way into the
government coffers rather than
reinvested into other projects.
The 'safe harbour' debt limit
for general entities has also been
reduced from a debt to value
ratio of 75 to 60 percent, in effect
from 1 July 2014. The change is
costing foreign investors $1.5
billion over the next four financial
years and will likely slow cross-
border investment activity.
The change will mean that
unless asset values have
risen 25 percent, companies
will be forced to either inject
equity and/or reduce debt.
Companies should consider
the likely effect this change will
have on the appropriate debt
valuation method; current financial
model assumptions which
incorporate the old safe harbour
limit; optimal capital structure;
returns to investors (especially
in structures which support
high levels of debt, such as
infrastructure); and cost of capital.